Business Continuation Planning
Business owners can benefit now, and in the future, from a properly structured continuation plan such as a buy-sell agreement.
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Have you thought about what will happen to the business you built if you become disabled or die? When planning what to do with the business upon one of these events, small business owners have essentially three alternatives to consider:
An important part of the business planning process is the development of a business continuation plan. Unfortunately, according to industry research, very few businesses have such a plan. And, if a plan is in place, often the financing is overlooked. If your plan is to dispose of the business in any way except liquidation, a business continuation plan is essential and involves at least two components: a Buy-Sell Agreement and a way to fund the buy-sell transaction. |
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The Buy-Sell Agreement
A Buy-Sell Agreement is a simple written agreement between you or the company and the intended purchasers of the business, that specifies the events that would trigger the sale and the provisions that would govern the transaction. A well designed Buy-Sell Agreement can:
Funding the Buy-Sell Agreement with Insurance
Using life insurance or disability insurance to provide the funding for the buy-sell transaction has proven to be the most efficient and desirable solution by far. Unless there is a 100% cash purchase being made, the alternatives to insurance can have significant drawbacks.
If the company is redeeming the ownership interest of the seller:
If co-owners/employees are purchasing the ownership interest:
Only life insurance or disability buy-out insurance can guarantee the full amount of the funds planned for, at the exact time they are needed. Additional benefits of insurance include:
Family Business Issues
It’s worth noting the unique planning considerations involved in buy-sell planning for family owned businesses. The first, most important question is “should the business remain in the family or be sold”? Over two thirds of the time the answer is to transfer the business ownership within the family. Relationship issues, fairness issues, and financial and tax issues are all significant aspects that enter the planning process. Frequently, several competing concerns have to be weighed:
A Buy-Sell Agreement is a simple written agreement between you or the company and the intended purchasers of the business, that specifies the events that would trigger the sale and the provisions that would govern the transaction. A well designed Buy-Sell Agreement can:
- Guarantee a buyer for your business.
- Document the value of your business, which negates the potential for a negotiation under pressure and establishes the value for estate tax purposes.
- Protect family members that are taking over the business from possible expectations of other family members.
- Financial equitability can be addressed.
- Motivate co-owner/employee buyers to build the business.
- Provide liquidity for your family and for the business when it is most needed.
Funding the Buy-Sell Agreement with Insurance
Using life insurance or disability insurance to provide the funding for the buy-sell transaction has proven to be the most efficient and desirable solution by far. Unless there is a 100% cash purchase being made, the alternatives to insurance can have significant drawbacks.
If the company is redeeming the ownership interest of the seller:
- Using existing cash reserves – these funds have usually been set aside for working capital or contingencies. At the time the business has just lost its’ owner, and the business faces financial pressures, is it wise to use this money? Plus, it usually only represents a fraction of the value of the company interest being redeemed.
- Installment payments using future company income – the seller’s heirs would be totally dependent on the future success of the business and have no guarantees.
- Borrowed money – expensive, difficult to obtain, and the heirs are subject to the same risk of the company being successful enough to generate sufficient cash flow for the debt service.
If co-owners/employees are purchasing the ownership interest:
- Installment payments using their personal income – unless the buyers are paying cash, the seller’s heirs face the same risk; the success of the company and the buyer’s ability to receive income from it.
Only life insurance or disability buy-out insurance can guarantee the full amount of the funds planned for, at the exact time they are needed. Additional benefits of insurance include:
- The funds are guaranteed to be available from the beginning of the agreement.
- Death benefits are generally free from federal income tax.
- The buyout funds are being created with “discounted dollars”.
- Cash value in permanent policies can be used for retirement buyout.
- The financial and credit position of the business is protected with an insurance funded agreement.
Family Business Issues
It’s worth noting the unique planning considerations involved in buy-sell planning for family owned businesses. The first, most important question is “should the business remain in the family or be sold”? Over two thirds of the time the answer is to transfer the business ownership within the family. Relationship issues, fairness issues, and financial and tax issues are all significant aspects that enter the planning process. Frequently, several competing concerns have to be weighed:
- The desire to pass the business to those family members who are active in the business, want to be the successors, and who may already have a minority ownership interest.
- The desire to treat children or other family members who are not involved in the business fairly and equitably.
- The desire to guarantee the financial security of the current owner and their spouse.